FOUR

CHAPTER

Financial Forecasting

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Figure 4-1
Development of pro forma statements
Foundations of Financial
Management
PPT 4-1

Prior balance
sheet

1 3
Sales Pro forma Pro forma
Production income
projection plan balance
statement sheet
2
Cash
budget

Other
supportive
budgets
Block
Hirt Capital budget
Short
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Table 4-1
Foundations of Financial
Management

Projected wheel and caster sales (first six months, 2000)

PPT 4-2

Goldman Corporation

Wheels Casters
Quantity . . . . . .1,000 2,000
Sales price . . . . . $30 $35
Sales revenue . . . . $30,000 $70,000
Total . . . . . . . . . . . . . . $100,000

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Table 4-2
Stock of beginning inventory
Foundations of Financial
Management
PPT 4-3

Wheels Casters

Quantity . . . 85 180
Cost . . . . $16 $20
Total value . . $1,360 $3,600
Total . . . . . . . . . . . . $4,960

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Table 4-3
Production requirements for six months
Foundations of Financial
Management
PPT 4-3

Wheels Casters
Projected unit sales (Table 4-1) . . . +1,000 +2,000
Desired ending inventory (assumed to
represent 10% of unit sales for the
time period) . . . . . . . . +100 +200
Beginning inventory (Table 4-2). . . – 85 –180
Units to be produced . . . . . . 1,015 2,020

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Table 4-4
Unit costs
Foundations of Financial
Management
PPT 4-3

Wheels Casters

Materials . . . . $10 $12

Labour . . . . . 5 6
Overhead . . . . 3 4
Total . . . . $18 $22

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Table 4-5
Total production costs
Foundations of Financial
Management
PPT 4-3

Wheels Casters

Units to be produced (Table 4-3) . . 1,015 2,020

Cost per unit (Table 4-4) . . . . $18 $22
Total cost . . . . . . . $18,270 $44,440 $62,710

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Table 4-6
Foundations of Financial
Management

Allocation of manufacturing costs and determination of gross

profits
PPT 4-3

Wheels Casters Combined

Quantity sold (Table 4-1) . . 1,000 2,000 3,000

Sales price . . . . . $ 30 $ 35
Sales revenue . . . . $30,000 $70,000 $100,000
Cost of goods sold:
Old inventory (Table 4-2)
Quantity (units) . . . 85 180
Cost per unit . . . $16 $20
Total . . . . . $1,360 $ 3,600
New inventory (the remainder)
Quantity (units) . . . 915 1,820
Cost per unit (Table 4-4) $18 $22
Total . . . . . 16,470 40,040
Total cost of goods sold . 17,830 43,640 $61,470
Block Gross profit . . . . . $12,170 $26,360 $38,530
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Table 4-7
Value of ending inventory
Foundations of Financial
Management
PPT 4-3

Beginning inventory (Table 4-2) . . . $ 4,960

+ Total production costs (Table 4-5) . . 62,710

Total inventory available for sales . . 67,670

- Cost of goods sold (Table 4-6) . . . 61,740

Ending inventory . . . . . $ 6,200

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Table 4-8
Foundations of Financial
Management
PPT 4-4

Pro Forma Income Statement

June 30, 2000
Sales revenue . . . . . . . $100,000
Cost of goods sold . . . . . . 61,470

Gross profit . . . . . . . 38,530

Selling, general and administrative expense 12,000

Operating profit (EBIT) 26,530

Interest expense . . . . . . 1,500

Earnings before taxes (EBT) . . . . 25,030

Taxes (20%) . . . . . . . 5,006

Earnings after taxes (EAT) . . . . 20,024

Common stock dividends . . . . 1,500

Block Increase in retained earnings. . . . $ 18,524

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Table 4-9
Monthly sales pattern
Foundations of Financial
Management
PPT 4-5

January February March April May June

$15,000 $10,000 $15,000 $25,000 $15,000 $20,000

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Table 4-10
Monthly cash receipts
Foundations of Financial
Management
PPT 4-5

December January February

Sales . . . . . . . $12,000 $15,000 $10,000
Collections:
(20% of current sales) . . $ 3,000 $ 2,000
Collections:
(80% of previous
month’s sales) . . . . 9,600 12,000
Total cash receipts . . $12,600 $14,000

March April May June

Sales . . . . . . . $15,000 $25,000 $15,000 $20,000
Collections:
(20% of current sales) . . $ 3,000 $ 5,000 $ 3,000 $ 4,000
Collections:
(80% of previous
Block month’s sales . . . . 8,000 12,000 20,000 12,000
Hirt Total cash receipts . . $11,000 $17,000 $23,000 $16,000
Short
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Table 4-11
Component costs of manufactured goods
Foundations of Financial
Management
PPT 4-6

Wheels
Units Cost Total
Produced per Unit Cost
Materials . . . 1,015 $10 $10,150
Labor . . . . 1,015 5 5,075
Overhead . . . 1,015 3 3,045

Casters
Units Cost Total Combined
Produced per Unit Cost Cost
Materials . . . 2,020 $12 $24,240 $34,390
Labor . . . . 2,020 6 12,120 17,195
Overhead . . . 2,020 4 8,080 11,125
Block $62,710
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Table 4-12
Average monthly manufacturing costs
Foundations of Financial
Management
PPT 4-6

Total Time Average

Costs Frame Monthly Cost

Materials . . . $34,390 6 months $5,732

Labor . . . . 17,195 6 months 2,866
Overhead . . . 11,125 6 months 1,854

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Table 4-13a
Foundations of Financial

Summary of all monthly cash payments (first part)

Management
PPT 4-6

December January February

From Table 4-12:

Monthly material purchase. . $4,500 $ 5,732 $ 5,732
Payment for material
(prior month’s purchase). . $ 4,500 $ 5,732
Monthly labor cost . . . . 2,866 2,866
Monthly overhead . . . . 1,854 1,854
From Table 4-8:
Selling, general and administrative
expense ($12,000 over
6 months) . . . . . 2,000 2,000
Interest expense . . . . .
Taxes (two equal payments) .
Cash dividend . . . . .
Also:
New equipment purchases . . 8,000
Block
Hirt
Total payments . . . . . $11,220 $20,452
Short
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Table 4-13b
Foundations of Financial

Summary of all monthly cash payments (final part)

Management
PPT 4-6

March April May June

From Table 4-12:
Monthly material purchase . . $ 5,732 $ 5,732 $ 5,732 $ 5,732
Payment for material
(prior month’s purchase) . . $ 5,732 $ 5,732 $ 5,732 $ 5,730*
Monthly labor cost . . . . 2,866 2,866 2,866 2,866
Monthly overhead . . . . 1,854 1,854 1,854 1,854
From Table 4-8:
Selling, general and administrative
expense ($12,000 over
6 months) . . . . . . 2,000 2,000 2,000 2,000
Interest expense . . . . . 1,500
Taxes (two equal payments) . . 2,503 2,503
Cash dividend . . . . . . 1,500
Also:
New equipment purchases . . 10,000
Block Total payments . . . . . $14,955 $12,452 $12,452 $27,953
Hirt *Adjusted for rounding.
Short
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Table 4-14
Monthly cash flow
Foundations of Financial
Management
PPT 4-7

January February March

Total receipts (Table 4-10) . . $12,600 $14,000 $11,000

Total payments (Table 4-13) . 11,220 20,452 14,955
Net cash flow . . . . . $ 1,380 ($ 6,452) ($ 3,955)

April May June

Total receipts (Table 4-10) . . $17,000 $23,000 $16,000

Total payments (Table 4-13) . 12,452 12,452 27,953
Net cash flow . . . . . $ 4,548 $10,548 ($11,953)

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Table 4-15
Cash budget with borrowing and repayment provisions
Foundations of Financial
Management
PPT 4-8

Jan. Feb. March April May June

1. Net cash flow . . . . . . $1,380 ($6,452) . ($3,955). $4,548 $10,548 ($11,953) .

2. Beginning cash balance . . 5,000.* 6,380 5,000 5,000 5,000 11,069

3. Cumulative cash balance. . 6,380 (72) . 1,045 9,548 15,548 (884) .

4. Monthly loan or (repayment) — 5,072 3,955 (4,548)

. (4,479). 5,884
.

5. Cumulative loan balance . . — 5,072 9,027 4,479 — 5,884

6. Ending cash balance . . . 6,380 5,000 5,000 5,000 11,069 5,000

* We assume the Goldman Corporation has a beginning cash balance of $5,000 on January 1, 2000, and it
desires a minimum monthly ending cash balance of $5,000.

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Table 4-16
Foundations of Financial

Balance Sheet
Management
PPT 4-9

December 31, 1999

Assets
Current assets:
Cash . . . . . . . . . . . . . $ 5,000
Marketable securities . . . . . . . . 3,200
Accounts receivable . . . . . . . . . 9,600
Inventory . . . . . . . . . . . . 4,960
Total current assets . . . . . . . . 22,760
Plant and equipment. . . . . . . . . . 27,740
Total assets . . . . . . . . . . . . $50,500
Liabilities and Shareholders’ Equity
Accounts payable . . . . . . . . . . $ 4,500
Long-term debt . . . . . . . . . . . 15,000
Common stock . . . . . . . . . . . 10,500
Block Retained earnings . . . . . . . . . . 20,500
Hirt Total liabilities and shareholders' equity . . . . $50,500
Short
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Figure 4-2
Foundations of Financial PPT 4-10

Development of a Pro Forma Balance Sheet

Management

Prior balance sheet

(Unchanged items)
Marketable securities
Long-term debt
Common stock

Pro forma income

statement analysis Pro forma
Inventory balance sheet
Retained earnings

Cash budget analysis

Cash
Accounts receivable
Block Plant and equipment
Hirt Accounts payable
Short Notes payable
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Table 4-17
Foundations of Financial PPT 4-11
Management

Pro Forma Balance Sheet

June 30, 2000
Assets
Current assets:
1. Cash . . . . . . . . . . . . $ 5,000
2. Marketable securities . . . . . . . . 3,200
3. Accounts receivable. . . . . . . . . 16,000
4. Inventory. . . . . . . . . . . . 6,200
Total current assets . . . . . . . 30,400
5. Plant and equipment . . . . . . . . 45,740
Total assets . . . . . . . . . . . . $76,140

Liabilities and Shareholders' Equity

6. Accounts payable . . . . . . . . . $ 5,732
7. Notes payable . . . . . . . . . . 5,884
8. Long-term debt . . . . . . . . . 15,000
9. Common stock. . . . . . . . . . 10,500
Block 10. Retained earnings . . . . . . . . . 39,024
Hirt Total liabilities and shareholders' equity . . . . $76,140
Short
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Table 4-18
Foundations of Financial PPT 4-12
Management

HOWARD CORPORATION
Balance Sheet and Percent-of-Sales Table
Assets Liabilities and Shareholders' Equity
Cash . . . . . . $ 5,000 Accounts payable . . . $ 40,000
Accounts receivable . . 40,000 Accrued expenses . . . 10,000
Inventory . . . . . 25,000 Notes payable . . . . 15,000
Total current assets . 70,000 Common stock . . . . 10,000
Equipment . . . . 50,000 Retained earnings . . . 45,000
Total assets . . . . $120,000 Total liabilities and
shareholders' equity. . $120,000
$200,000 sales
Percent of Sales
Cash . . . . . . 2.5% Accounts payable . . . 20.0%
Accounts receivable . . 20.0 Accrued expenses . . . 5.0
Inventory . . . . . 12.5 25.0%
Block Total current assets . 35.0
Hirt Equipment . . . . 25.0
Short 60.0%
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Table 4-19
Balance sheet with sales increase
Foundations of Financial PPT 4-13
Management

HOWARD CORPORATION
Sales $200,000
Sales increase 50.00% $100,000
Assets Before Increase After
Cash $ 5,000 $ 2,500 $ 7,500
Accounts receivable 40,000 20,000 60,000
Inventory 25,000 12,500 37,500
Total current assets $ 70,000 35,000 105,000
Equipment 50,000 25,000 75,000
Total assets $120,000 $60,000 $180,000

Liabilities and Shareholders’ Equity

Accounts payable $ 40,000 $20,000 $ 60,000

Accrued expenses 10,000 5,000 15,000
Notes payable 15,000 15,000
Required new funds 26,000←←
Total current liabilities $ 65,000 $116,000
Common stock 10,000 10,000
Retained earnings 45,000 9,000 54,000
Total liabilities and shareholders’
equity $120,000 $34,000 180,000

Selected ratios
Block
Debt/Total assets 65/120 =.054 116/180 =.064
Hirt Debt/Equity 65/(10+45) =1.18 116(10+54) =1.81
Short Current ratio 70/65 =1.08 105/116 =0.91
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Table 4-20
Balance sheet with sustainable sales increase
Foundations of Financial PPT 4-14
Management

HOWARD CORPORATION
Sales $200,000
Sales increase 12.24% $ 24,480
Assets Before Increase After
Cash $ 5,000 $ 612 $ 5,612
Accounts receivable 40,000 4,896 44,896
Inventory 25,000 3,060 28,060
Total current assets $ 70,000 8,568 78,568
Equipment 50,000 6,120 56,120
Total assets $120,000 $14,688 $134,688

Liabilities and Shareholders’ Equity

Accounts payable $ 40,000 $ 4,896 $ 44,896

Accrued expenses 10,000 1,224 11,224
Notes payable 15,000 15,000
Required new funds ←
1,834←
Total current liabilities $ 65,000 6,120 $ 72,954
Common stock 10,000 10,000
Retained earnings 45,000 6,734 51,734
Total liabilities and shareholders’
equity $120,000 $12,854 $134,688

Selected ratios
Block
Debt/Total assets 65/120 =0.54 73/135 =0.54
Hirt Debt/Equity 65/(10+45) =1.18 73/(10+52) =1.18
Short Current ratio 70/65 =1.08 79/73 =1.08
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Chapter 4 - Outline
Foundations of Financial
Management

LT 4-1

• What is Financial Forecasting?

• 3 Financial Statements for Forecasting

• Determining Production Requirements

• 2 Methods of Financial Forecasting

Block • Percent-of-Sales Method

Hirt
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What is Financial Forecasting?

Foundations of Financial
Management

LT 4-2

• Financial forecasting is looking ahead to develop a

financial plan for the future

• Provides lead time to make necessary adjustments before

actual events occur

• Helps to plan for significant growth in firm

• Can be used as a target for measuring performance

Block • Often required by bankers and other lenders

Hirt
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3 Financial Statements for Forecasting

Foundations of Financial
Management

LT 4-3

• Pro Forma Income Statement (I/S)

• Cash Budget
• Pro Forma Balance Sheet (B/S)

The first step is to develop a sales projection

Block
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Foundations of Financial

Determining Production Requirements

Management

LT 4-4

Projected Units Sales PLUS

Desired Ending Inventory (EI) MINUS
Beginning Inventory (BI) EQUALS

Production Requirements
(or Units to be Produced)

Block
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Foundations of Financial

2 Methods of Financial Forecasting:

Management

LT 4-5

– Using Pro Forma, or Projected, Financial

Statements (more exact, time consuming)

– Percent-of-Sales Method for the pro forma

Balance Sheet

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Percent-of-Sales Method
Foundations of Financial
Management

LT 4-6

• A short-cut, less exact, easier method of determining

financing needs
(The “quick and dirty” approach)

• Assumes that B/S accounts will maintain a constant

percentage relationship to sales

• More sales will mean more assets which will require more
financing

Block • Can be summarized by using the Required New Funding

Hirt formula
Short
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